The Mutual Fund Show: The Dos and Don'ts Of Investing
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The Mutual Fund Show: The Dos and Don'ts Of Investing

Professional management, superior returns over long term, diversification and discipline make investing in mutual funds convenient. Still, increased uncertainties or volatility may cause decision-making of investors to break down, prompting them to act basis bias and emotion.

Vishal Dhawan, founder and chief executive officer at Plan Wealth Advisors, and Anant Ladha, founder of Invest Aaj for Kal, list the dos and dont’s while investing in mutual funds on BloombergQuint’s weekly special series The Mutual Fund Show.

“Recency-bias is one of the biggest mistakes any investor can do in their complete investing life,” Ladha said.

According to Dhawan, it’s important to keep in mind that a mutual fund is an investment vehicle and not a trading instrument.

What Dhawan Says To Do

  • Look at the mix of your portfolio before adding any sectoral ETF or funds into it. For instance, financials have about 35% weight in the Nifty 50. Adding more sectoral exposure through a banking and financial services fund may result in a highly skewed portfolio towards such stocks

  • Look at the credit quality carefully

  • Maintain a good mix of active and passive strategies

  • Cost of investing

  • Good mix of active and passive strategies

What Dhawan Says To Avoid

  • Do not pick funds merely on historical performance, without looking at underlying fundamentals

  • Don’t remain invested in an underperformer, based on the theory that the biggest loser will gain the most

  • Avoid chasing yields in a debt fund

What Ladha Says Must Do

  • Have a goal-based investment planning

  • Mapping investment with time horizon

  • Giving time to investments

  • Consistency in mindset and investment

  • Lumpsum investment whenever there is more than 30% corection

What Ladha Says Must Avoid

  • Don’t set wrong expectations of 12-15% returns considering it will accrue like fixed deposits on an yearly basis, because equity fund can give very volatile returns

  • Avoid herd mentality. Don’t invest because your friend is doing so.

To know why the advisers say so, watch the full show here:

Also read: The Mutual Fund Show: How To Assess A Fund’s Performance

Here are the edited excerpts:

Vishal, a key thing which you believe people make a mistake while doing their investments.

Dhawan: So I think the biggest thing that we come across especially in recent times is starting to treat mutual funds like a trading instrument very much like they buy equities and they want to come in and go out of mutual funds as if it was a stock without realising that this is actually the job of the fund manager and he’s doing this on a daily basis.

It’s important to keep in mind that a mutual fund is an investment vehicle and not a trading instrument.

Anant, same question to you.

Ladha: I feel one of the biggest mistakes which any investor can do in mutual funds is giving too much importance to the recent returns. When they see good returns in gold, they try and run after gold, when they see good returns in equity, they try and chase equity, when they see good returns in long-term debt products, they feel that now it is the perfect time to use debt funds and then they try and run after the debt products for that matter.

Recency-bias is one of the biggest mistakes any investor can do in their complete investing life.

Vishal, the key dos for mutual fund investor you are saying look at the mix of your portfolio before adding any sectoral ETF for funds in the portfolio. Why do you say this? Do you see investors doing this quite frequently?

Dhawan: Yes, it’s quite common to find sectors that come in and out of favour. And what a lot of investors do is they try to supplement their broad diversified equity exposure with additional exposure to sectoral funds without necessarily realising that their fund manager might actually be doing the same thing when he’s constructing the rest of his portfolio. A fairly simple example is banking and financial services. We all know that the banking financial services sector is actually a very large contributor to the index itself. It makes up anywhere between 33% and 35% of broad indices. We saw what happened a few months ago when the sector was in favour, people bought sectoral funds on top of that which was also banking and financial services and therefore ended up with a portfolio which may have been very overweight on that sector. Therefore, effectively their portfolio returns were dictated on how that one sector did or did not do rather than have a truly diversified portfolio.

The other bit Vishal that you say in terms of dos is focusing on cost. Lower expenses will obviously mean higher returns but if somebody’s seeking the help of an adviser, people might just get confused because people would believe that direct investing would be low expense while having an adviser would be high expense. So, do you mean that or are you recommending it in some other way?

Dhawan: Mutual funds are not just about equity. There’s also debt in there and what tends to happen with debt is that the amount of potential return is much lower compared to what an asset like equity can deliver. Therefore, if you don’t keep your costs of the debt fund under control, you could end up buying something just too expensive and therefore don’t get net returns which are high enough. Similarly, if you buy index funds which are low cost, you could end up having a good outcome as well.

...Cost going forward is a very important indicator and actually one of the few controllable things you have as a mutual fund investor when you try to think about how to generate returns in portfolio.

Anant, I’ve heard pros and cons for goals-based investing or goal-based planning. Why do you recommend this?

Ladha: Without a goal, investing is like going on a war without having a plan or strategy. I know goal-based investing is very easy but it is not simple to apply. We have to be very sure that we have a proper goal-based investing in mind. Investing without a goal is like going on a walk without knowing the final destination. So the initial step and the first step of any financial plan has to be a goal planning and that is required not just because I am saying it or someone else is saying it, but because every investor needs it. It’s the need of the hour for every investor and it is the starting point which we have to take care of.

Vishal, would goal-based investing really work all the time? One of the views is that if you invest with a goal in mind, once the goal is reached, you would actually take off the investment as opposed to staying put in what could actually be a well-performing mutual fund scheme.

Dhawan: Well that is a risk that you run because effectively it ultimately boils down to market timing and being successful and being able to get in and get out of an asset class at the right time or the wrong time, but I think it’s good to look at this just from the year 2020 use case. So if you look at year 2020—let’s assume that you had a financial goal that you needed to achieve in the middle of the year and we got into 2020 in an environment where the general view was that India is on a recovery path and as you reached June you had an event like Covid which disrupted businesses and created lots of panic in the stock market as well. Now, if you had this goal come up in June, ideally what you would have been doing is somewhere  around last year itself you would have started to move some of your money away from equities to be able to control that risk. And you could have reached June of this year and found that you have most of your money already kept aside for the goal so that you don’t have to worry about what happened to the stock market. So I think as a use case, 2020 has been an excellent example of why goal-based investing works well, provided you follow it in a much disciplined manner.

Anant, your second point is mapping the right investing to right time horizon. What do you mean by this?

Ladha: It is also somewhere linked to goal-based planning. For example, if our goal is in the near term, we would have to map it with a debt product or a liquid product for that matter. And if our investment time horizon is more than 10 years, only then we should go to equity. So if we don’t have that goal in mind, we really don’t know that whether we should use a debt product or an equity product or which is actually the right asset class for an investor. So, what I have seen is many investors have money parked in maybe fixed deposits or fixed instrument type of products. These are investments which are there for maybe around 10 years or 15 years and they come to equity share market to become millionaires or maybe billionaires overnight. So this is something which we have to take care of.

Everything which we invest in has to be based on a time horizon, which we will have to decide before investing and make sure that we are sticking to it during the complete cycle of investment.

The interesting bit is also consistency in mind-set and investment. What do you mean by this Anant?

Ladha: Consistency in mind-set means a very simple thing. When we start investing we have a time horizon of maybe 10 years or maybe 15 years for that matter, but whenever there is correction in the equity share market, our time horizon gets shifted from 15 years to 15 days overnight. Even we don’t know that we are shifting our complete mind-set. For this I’ll again try to put one point. In the Indian space or in an Indian equity share market or an Indian investment lifestyle, every investor is a loss-averse investor. They are ready to take some risk provided that their investment or their portfolio is not in negative. This is one point which we have to take care of so that the consistency in the mind-set is always there and they stick with their time horizon and to ensure that the complete portfolio doesn’t go negative or even if it is going negative, there’s a slight justification and they have a portfolio of behind the debt portfolio which is taking care of their volatility part. We have to make sure that every investor has a good amount invested in a debt fund and proper asset allocation is followed keeping his goal setting in mind.

Vishal advises to avoid chasing yields in a debt fund and look at the credit quality carefully. This advice couldn’t be more true, especially in the last 2.5 years, but can you tell us how do people go about doing this, let’s say if an average retail investor doesn’t have the support of a good adviser?

Dhawan: So, this is again a very good time to talk about this because we’re announcing yields on high-quality debt funds being very low. I think most high-quality debt funds would have anywhere between 5% and 6% and nothing beyond that. And for most investors who are today looking at debt mutual funds, there is a desire for a higher rate because it seems very much in line with what the low fixed deposit rates are for example. The way that we’ve always looked at this is that you only get a higher return because you’re willing to take a higher level of risk, and unfortunately most debt fund investors are not really seeking higher risk. They’re more looking like they want the same level of risk as a bank deposit but they want a higher rate of return. So our view has been that debt funds work for investors in two manners.

  1. If interest rates go down, they tend to have the ability to give you some capital appreciation and in a developing economy you would find that over a long period of time interest rates do tend to trend downwards even though it’s not a straight line.

  2. What always happens is that for a lot of investors on higher tax brackets, debt mutual funds are very tax efficient if you hold them for more than three years.

So the way that we look at a debt fund investment option is that, don’t chase the yield because the yield will come with higher risk. Look at AAA, AA and A ratings, these are all published in the fact sheets, but that itself may not be good enough. A YTM (yield to maturity), which is published on the portfolio, plus the expense of that fund, normally is a very good indicator for investors to understand what kind of a risk they’re taking and whether they’re comfortable with that risk or not.

Vishal, you also advocate having a good mix of active and passive strategies. Can you elaborate a bit on that point?

Dhwan: So there’s always been this debate over many years that India is actually an active investing market where information, arbitrage and asymmetry exists, and passive works very well internationally but not so well in India because of the information arbitrage. Now the data very interestingly does seem to show that for certain categories of mutual funds, especially large cap for example, most active managers are not able to beat passive managers and this has got accentuated once the measurement started to move against the total return index. It’s also about accentuated as expenses on passive funds had become very low and active funds have still been quite expensive.

When you look at a portfolio, you need to have a combination of what we believe are core market kind of strategies where you just want market exposure and want to get returns which are equivalent to what the market delivers, and then you want to have some satellite or tactical strategies where you try to get a higher rate of return, and therefore when you combine active and passive strategies, you’re able to achieve both these objectives very well.

Vishal, you recommend treating the mutual fund as an investment instrument.

Dhawan: Yes, I think it’s a very important point because I think a lot of people, especially with the proliferation of ETFs have started to use a lot of mutual fund instruments as you know vehicles where you can participate in an upward trending market for a short while and then exit. Especially in products where exit loads are low or the exit load periods are short, there is a greater tendency to do that because somehow the message there is that a lot of retail investors think this is a short-term strategy because the exit load is only for a few days or a few months and nothing could be further away from the truth that ultimately if you’re going to be using equity as an underlying instrument, the need for remaining long term in that instrument is absolutely critical. Therefore, we need to remember that if you want to do any sort of trading, which any way we think is a very very risky strategy for retail investors, if you need to do that do it with a select set of stocks, do it with a very small amount of your capital, understand the risks involved but don’t convert a mutual fund into a trading instrument.

Anant, you have a view that if an index fund for example comes off by 20-30%, then people should do a lump sum investing. That would not be a norm, right? You’d probably need to study the fundamentals of the sector before you decide to do that?

Ladha: You’re absolutely right, we have to study. We study the fundamentals but there is one thing which I want to point forward. Every time there is a correction, we feel that I will do bottom-fishing. Let market correct some more, then I’ll put some lump-sum investment. Whenever market is correcting everyone knows that there is an opportunity out there, but how many of us are able to actually crystallise it? I really doubt it. So, for that we need a rule. Rules always work, emotion never works. What happens is when we have rules in place; we always make sure that we are following those rules. One such rule can be—whenever index is falling 30% and 30% correction will always come whenever there is some severe bad news in the market. Obviously, there are chances of market correcting more but we do not know what the bottom of the market is, like what just happened in March. But if we have a rule in place that whenever market corrects by 30%, I will try and put some lump-sum amount. It will completely depend on person-to-person what amount of lump sum he or she is putting but some lump sum amount can always be placed whenever there is a 30% crack in the major index. So, if Nifty is correcting by 30%, obviously there is some big reason because of which this correction is coming and there is a lot of fear in the market. At that time, it is really not possible to invest if we don’t have our rules in place. So, one such rule which I follow and which I always suggest everyone to follow is to have a strong conviction on the growth story of India, on the equity market of India and make sure that you invest some amount of lump-sum whenever there is a 30% reduction in the equity share market.

Also read: The Mutual Fund Show: What Investors Must Keep In Mind While Choosing A Mutual Fund

‘Not giving too much of importance to the recent returns’, I think that’s probably the cardinal sin that most people tend to commit. Anant, do a large proportion of your clients do that too?

Ladha: This is one point which every investor tends to do in his or her investment life. For example, I am a big follower of equity markets and I always suggest that some portion or some allocation should always go into equity funds, but I don’t want investor to allocate in equity funds just because it has performed in the last four months or five months. Seeing a short-term time horizon and deciding on the basis of short-term time horizons is one mistake which many of us tend to do. The same mistake was committed while investing in gold. Whenever gold has already given over 60% returns, many investors were trying to chase gold thinking that it will continue to give the 60% return lifelong... Emotion always says that what has happened in last one year will continue to happen forever. We have to make sure that we do not make this mistake.

Vishal, there is a relevant example of G-secs that you’re trying to say—the historical performance having made the basis.

Dhawan: Absolutely. In fact it gets even more complex when you look at things like government securities because first of all, there is already a tendency for investors to want to be in instruments that they perceive as very safe. And when interest rates fall like they have in the last few quarters and the returns tend to be very very strong as a result, there is a tendency to go overweight on instruments like G-sec fund for example, without realising that interest rates may not fall in the same manner going forward or in fact even maybe head upwards. In that case the same instrument which is perceived as very safe actually starts to deliver negative or low returns. So I think it’s important for investors to understand that investing using a review is not a great idea. It’s good to get a sense on what has happened in the past, but it’s important to look forward and make those choices.

Vishal, you’re saying ‘don’t give excessive weightage to the personality or brand of mutual funds’. What do you mean by this?

Dhawan: So I think most people tend to buy products basis brands and therefore they may have conferred with certain for example bank brands and therefore one of my investment products from any of those bank brands that they’re more familiar with or they may find that there are some brands that are from overseas which they might feel that because it’s from overseas maybe it’s better or in certain cases people might feel that something that is local is actually better. In our view none of that actually is important.

What people have to get into is understanding what is the process that gets followed at a particular mutual fund level. What’s the kind of philosophy that’s getting followed by a particular fund manager managing a particular scheme and do they agree with that philosophy or not.

For example, there might be a fund manager who follows a value style of investing which means that he is very patient, he buys stocks which are at a discount to their intrinsic value and is happy to stay invested for a long period of time before that stock reaches its fair value. Now if as an investor you are quite the opposite where you want to participate in high growth stories, you might find that there’s a big mismatch between the philosophy and the process that the fund house or the fund manager follows versus what you expect. Therefore, just picking the fund on the basis of the brand may actually give you very sub-optimal outcomes.

Anant, among the dont's, we already spoke about the recency returns. The other bit is setting wrong return expectations. Care to elaborate a bit on that?

Ladha: I’ve always believed that we should always have realistic returns in mind. Whenever we are investing in equity especially, we have to make sure that we set the 12% returns in mind, but at the same time we have to make sure that this 12% won’t be coming on a yearly basis like it comes in a fixed deposit or in a debt fund. There’ll be volatility throughout this complete cycle. There’ll be years when there are super good returns versus there will be years where there is under-performance in any of the mutual funds. So, we have to always be ready for this volatility, especially when we are investing in equity. At the same time we have to make sure that we are investing in debt and not ignoring debt as a whole because that will give stability to our portfolio.

Anant, the last two points of yours—herd mentality which people typically tend to do in stocks and probably funds, and following blindly the reality of 100-minus-age rule. Can you talk about that?

Ladha: There is a very famous rule which everyone kind of follows that 100 minus your age is the amount of equity exposure which you should have. I really don’t agree with this rule. Suppose there is a 30-year old young champ who has a home loan and who has even committed to some short-term debts and then he is investing 70% in equity, I really don’t think so that it is relevant for him.

Goal planning and financial planning is something which is very personalised. When it is personalised, we can have some basic general rules, but generalising asset allocation can be very dangerous and very harmful to long-term investing.

The second last point was the herd mentality. I don’t want investors to come into mutual fund and invest just because nowadays he or she is hearing everywhere that ‘mutual funds sahi hai’. He has to himself assess whether a product is useful for him or her or not. If it’s not useful, then they can probably avoid it also but they should not invest in any of the asset class for that matter just because their friends are investing in the same asset class.

Vishal, point number three—remaining invested in an underperformer. I think this happens in stocks as well. Are you saying it happens in funds, too?

Dhawan: Yes, it happens very often because when you stay invested in something which is not doing well, mentally you feel that it will do something going forward. When you actually exit, you kind of think that you made a mistake. So we see this happen very often where people just stay on with an under-performing scheme for a very long period of time. I think it’s important to set a time frame before which you will reassess that decision. Maybe your exit choice needs to be done after you’ve done an independent assessment. Maybe you’re going to be exiting out gradually and not everything together, but don’t just stay invested there because you believe that anything which has under-performed in the past will out-perform in the future. There is no such math that is obvious.

Vishal, number five point, which is defining long term is three to five years for equity investing in mutual funds. You are saying it should be longer? Also number four, which is adopting the same pace of investment in every phase of the market.

Dhawan: I’m just going to talk about number four first because I think a lot of people have believed that you know an SIP strategy is a relevant strategy irrespective of what’s happening in financial markets. And our view is that while an SIP strategy is excellent in terms of discipline investing and ensuring that you have some sort of investing happening, if markets do end up becoming expensive; for example, a Nifty had a P/E of 32 may not require you to invest at the same pace as when the Nifty is at 16 times. So when it’s at 16, you might want to invest more and when it’s at 32 you might want to invest less.

You need to stagger your investment pace depending on how valuations are.

As far as three to five years are concerned, I think this is again important because, if you go back in history and look at data, you find that for equity markets to become lower risk investment options, your investment horizon actually needs to be 10 to 15 years and not three to five years. And on top of that you see this getting even more complex when SIP investors count their starting date of the SIP and then measure three years from their start date without realising that their SIP is actually going in every month and therefore even if they’ve stayed invested for five years, their effective holding period for the investment has been only 2.5 years.

I think for most investors if they’re taking equity-based mutual fund decisions, they should be having a 10-15-year investment horizon to really be able to askew and do away with the risk of downside in equity investing.

Also read: The Mutual Fund Show: Understanding The Basics Of Investing

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